UN-ATAF Workshop on Transfer Pricing LEARNING OBJECTIVES Administrative Aspects and Recent Developments Ezulwini, Swaziland 4-8 December 2017 What is transfer pricing? INTRODUCTION TO Understanding the basic Conducting a Transfer The arm’s length Pricing Analysis elements principle TRANSFER PRICING of transfer pricing Monday, 4 December 2017 9.30am – 11.00am Legal Environment 2 OVERVIEW What is transfer pricing and why is it important? The arm’s’ length principle Elements of a transfer pricing analysis: - Functional analysis What is Transfer Pricing and - Comparables and comparability analysis Why is it Important? - Transfer pricing methods The business framework The legal environment 3 4 1 A SIMPLE EXAMPLE QUESTIONS Company A manufactures automobiles in Japan that are ultimately to How much should should Company A charge Company be sold to customers in Germany. B for the automobiles? The automobiles are sold by Company A to its distribution subsidiary in a. € 9,000 Germany, Company B. Company B resells the automobiles to independent dealers. b. € 10,500 The automobiles cost € 10,000 per unit to develop and build. c. € 13,000 The customers pay € 20,000 for the automobiles at retail. d. € 15,000 The independent dealers earn gross profit of 15% of the end sale price or € 3,000 per automobile. That is, they buy automobiles from e. € 17,000 Company B at a price of € 17,000 per unit. f. Cannot tell based on the information presented That leaves € 7,000 (20,000 – 3,000 – 10,000) to cover freight, selling / marketing costs, and overhead costs, to fund development of new car models and technology, and to provide profit for Company A and Company B. 5 6 QUESTIONS QUESTIONS What additional facts do you need to know in order to identify an What are the tax consequences of any possible answer arm’s length price? to the question of what is the right price? a. Profit margins of other manufacturers? b. Company B’s distribution costs? c. Per unit freight costs from Japan to Germany? - For Japan d. Retail prices charged by competing companies for their cars? - For Germany e. Prices charged selling similar cars to unrelated dealers in Japan? - For the automobile company f. Company A’s total investment in manufacturing plant and equipment? g. Whether Company A uses the same brand in Japan and Germany? h. Anything else? 7 8 2 WHAT IS TRANSFER PRICING KEY TERMS IN THE DEFINITION Cross-border UN Practical Manual Para 1.1.6. Transactions Between “related” parties or “associated enterprises” “Transfer pricing is the general term for the pricing of cross-border, intra-firm transactions between related parties. Transfer pricing refers to the setting of prices for transactions between associated enterprises involving the transfer of property or services.” 9 10 EXAMPLES OF TRANSACTIONS REQUIRING TRANSFER WORDS NOT FOUND IN THE DEFINITION PRICING ANALYSIS Profit shifting Sales of tangible goods including finished inventory, parts and Manipulation components, and commodity products. Provision of services including corporate administration, sales Transfer mispricing and marketing, research, other technical services, etc. Tax avoidance Transfers of intangibles including rights to use patents, trademarks, brands, technical know-how, etc. Financial transactions including loans, financial guarantees, Key concept: Transfer pricing is a normal part of performance guarantees, related party insurance international commerce. While companies can, and arrangements, derivatives. sometimes do, manipulate related party prices for Etc., etc., etc. tax advantage, tax authorities need to be concerned about whether the right prices are charged even Intra – group transactions constitute at least 30 percent of where intentional, tax motivated price manipulation global trade. is not present. 11 12 3 OBJECTIVES OF A TRANSFER PRICING ANALYSIS Determine the proper prices for transactions between associated enterprises. Make sure that the resulting allocation of income between taxing jurisdictions reflects the underlying The Arm’s Length Principle economic activity. Reach cross border agreements on proper pricing among the taxpayer and the affected countries. Avoid double taxation. 13 14 ARM’S LENGTH PRINCIPLE RATIONALE FOR APPLYING THE ARM’S LENGTH PRINCIPLE Stated most simply, the arm’s length principle requires the prices and other conditions of transactions between The rationale for the arm’s length principle is that associated enterprises (related parties) to be the same because markets govern transactions between unrelated as the prices and other conditions that would be parties, determination of prices for related party established in comparable transactions between transactions on the basis of the prices charged or independent enterprises (unrelated parties). margins earned in comparable unrelated party transactions will assure a market based allocation of income between the related parties. 15 16 4 CENTRAL ROLE OF THE UN AND OECD MODEL ARM’S LENGTH PRINCIPLE ARTICLE 9 (1) The arm’s length principle is the generally accepted guiding principle 1. Where: used in establishing acceptable transfer prices. (a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, The transfer pricing rules in nearly all countries are based on the or arm’s length principle. (b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Nearly all bilateral tax treaties commit countries to follow the arm’s Contracting State, length principle. Article 9 of both the UN and OECD Model Treaties and in either case conditions are made or imposed between the two enterprises incorporates the arm’s length principle. in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for Consistent application of the arm’s length principle across countries those conditions, have accrued to one of the enterprises, but, by reason of makes it possible to resolve transfer pricing disputes and to avoid those conditions, have not so accrued, may be included in the profits of that double taxation – The need to resolve disputes makes it important to enterprise and taxed accordingly. have a single set of rules. 17 18 SOURCES OF GUIDANCE ON THE ALP The UN Practical Manual on Transfer Pricing for Developing Countries, first published in 2012 and expanded and updated in 2017. The UN manual provides practical advice on applying the arm’s length principle in many situations relevant to developing countries. Conducting a Transfer The OECD Transfer Pricing Guidelines (updated in 2017) provide Pricing Analysis detailed guidance on applying the arm’s length principle. They are accepted and followed by most countries and they are routinely used in resolving cross border transfer pricing disputes. The UN Manual and the OECD Guidelines are generally consistent. There are also numerous decided court cases from countries around the world that apply the ALP. 19 20 5 APPLYING THE ARM’S LENGTH PRINCIPLE FUNCTIONAL ANALYSIS A functional analysis is the process used to assemble the Transfer pricing under the arm’s length principle is based economically relevant facts for a transfer pricing analysis. on comparing controlled transactions to uncontrolled Key elements of the functional analysis may include: transactions. Understanding the overall process by which the MNE creates There are three key steps in a transfer pricing analysis: value and the key factors contributing to value creation in its global business. - Get the relevant facts – functional analysis; Identifying the relevant cross border transactions between associated enterprises. - Identify useful comparable transactions or Identifying the specific terms of those transactions by reference relationships – comparability analysis; to written contracts and the actual conduct of the parties. - Select and apply the most appropriate transfer pricing Identifying specifically the functions performed, assets used, and method. risks assumed by each of the parties in relation to the identified transactions – Accurately Delineating the Transaction . 21 22 SOURCES OF INFORMATION COMPARABLES ON TAXPAYERS’ TRANSACTIONS Application of the arm’s length principle is usually based on a Written contracts, invoices, payments, etc. comparison of the conditions of a controlled transaction with the conditions of transactions between independent Conduct of parties enterprises What did they actually do The comparison is only useful if the economically relevant Was it consistent with the contracts circumstances of the controlled and uncontrolled transactions Are there activities undertaken or risks assumed not being compared are sufficiently similar, i.e. if they are in fact comparable covered by the contracts Are functions assigned to a party under the contract To be comparable means that none of the differences which that party lacks the capability to perform between the situations being compared could materially affect the price for the transaction, or if material differences do exist, reasonably accurate adjustments can be made to eliminate the effect of such differences on prices. 23 24 6 COMPARABILITY FACTORS COMPARABILITY ADJUSTMENTS The relevant factors to consider in evaluating comparability In some situations comparability adjustments should be